Bulgarian New Year's Eve
revellers had good reason to celebrate the coming of 2007 as their
country joined the EU on a day President Georgi Parvanov described
as one of the most important in the country's history. The
significant boost in economic confidence and political sentiment by
gaining membership in the bloc and the subsequent challenges were
central themes of the past twelve months.

Those who welcomed
in the New Year by singing the EU anthem and watching the
accompanying fireworks display in Sofia's central square did not
need to wrap up as warm as they might have expected as the country
experienced one of its mildest winters in recent years. The lack of
snow on the country's slopes played havoc with the ski season,
although this picked up later in the year with heavy snowfall in
November.

The mild winter and a series of later floods and
fires led to a poor harvest and pushed food prices up throughout the
course of the year. When combined with the global rise in fuel
prices, the resulting high inflation of over 11% year-on-year
resulted in serious doubts as to whether the country would be able
to fulfil the Maastricht Criteria on inflation levels in order to
convert to the euro currency in 2010.

The government's
attempts to curb inflation were hindered by the currency board,
which pegs the lev to the euro and denies the government many
monetary controls such as setting the interest rate. This was
highlighted by the Bulgarian National Bank's (BNB) attempts to rein
in spiralling credit lending in the banking sector. Unable to raise
central interest rates due to the currency board the BNB increased
minimum reserve requirements from 8% to 12%. However, in a country
where 95% of the banks are foreign owned and can source funds from
their headquarters, most chose to absorb the additional costs to
remain attractive in an increasingly competitive sector.

The
currency board was, however, instrumental in enabling the finance
ministry to maintain a tight fiscal policy in 2007. It was aided by
a simplified tax system, central to which was the new flat rate
corporate tax of 10% - the lowest in Europe - introduced on January
1.

The success of the flat tax, which saw state revenues
increase by 23% while collection costs fell, has galvanised the
government to introduce a personal income tax of 10% in 2008 and
allowed the treasury to notch up a record budget surplus of 3.05bn
levs ($2.3bn) in the first nine months of the year.

The
government was not the only one to feel its pockets filling up.
Boosted by EU membership and the new flat tax, 2007 was a strong
year for private enterprise. GDP grew at over 6% and the country
attracted 5bn euros (almost $7.4bn) in foreign direct investment.

Up to half of this was targeted at the real estate sector
where the construction and development of residential, office and
retail space continued apace. Fears of a slowdown in British and
Irish second homebuyers were tempered by the increasing interest of
Romanians, Russians and Northern Europeans.

The large inflow of foreign
capital into the real estate sector, combined with a rising trade
deficit as Bulgarian companies purchased investment goods from
abroad, led to a yawning current account deficit in 2007, that is
expected to be about 20% of GDP. This was criticised by the
International Monetary Fund but many government and independent
analysts have downplayed its significance, saying it is a natural
response to the country's continuing attraction of FDI. The current
account deficit is also financed by FDI.

Perhaps a more
significant challenge to the country's long-term sustainable
development was highlighted by reports from the World Bank and the
Belgium-based Lisbon Council for Economic Competitiveness and Social
renewal, a think tank. Human resources remain at a premium in
Bulgaria with employers finding it increasingly difficult to attract
sufficient numbers of qualified candidates. As a result wages in
some professions such as engineering and internet technology
programming have risen exponentially in the last three years, albeit
from a low base.

With private sector salaries rising rapidly,
it was perhaps inevitable that public sector workers looked to gain
from the country's strong economic growth. In October central Sofia
was regularly brought to a standstill as the nation's teachers went
on strike, demanding the government surplus be used to raise their
salaries 100%. After six weeks of strikes, a settlement was reached,
giving teachers a cumulative 45% pay rise.

In the aftermath
of the strikes, the Citizens for Bulgaria's European Development
(GERB) party, which strongly supported the teachers' strike, fared
very well in the country's municipal elections, with the party's de
facto leader, the popular former policeman Boyko Borissov, retaining
his role as mayor of Sofia.

The ruling Bulgarian Socialist
Party will have reason for concern given the growth of the GERB as
the 2009 parliamentary elections approach. However, if it continues
to maintain the tight fiscal policy that has reaped rewards in
recent years, introduce effective reforms to the nation's education
system and use EU funds wisely to improve the country's key
infrastructure, the potential for future economic growth remains
good.